Answer to In class exercises on CAPM students0

Answer to In class exercises on CAPM students0 - A nswer to...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Answer to In class exercises on CAPM 1) a. The CAPM assumptions imply that the best possible risk-return combinations are combinations of the risk free security and the market portfolio- portfolios on the CML. Let us find the CAML portfolio that has an expected return of 9%, equal to the McDonald’s return. We need to determine the proportion to invest in the market so that 9%= 4%*(1-x) + 10%*x. Solving for x gives x=0.8333. Therefore you should invest $8,333 in the market portfolio and $1,667 in the risk free security. The volatility of this portfolio is 0.8333 * 16% =13.3% (much lower than 27%). Notice that 0.833 is also the beta of McDonald: beta is the factor loading on the market portfolio b. Alternatively we can choose the CML portfolio that matches McDonald’s volatility of 27%. To do so we need to invest a proportion x such that 27% = x * 16%. Solving for x gives x=1.6875 so the expected return is 4%*(-0.6975) + 1.6875*10% = 14.1% a much higher expected return than 9%. To form this portfolio, you need to borrow $6,875 and
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 04/17/2011 for the course COMM 299 taught by Professor Desrochers during the Spring '08 term at UBC.

Page1 / 3

Answer to In class exercises on CAPM students0 - A nswer to...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online